How Stimulating is China’s “Stimulus”?

China’s economy has been slowing for six consecutive quarters. The data so far for August and July 2012 suggests that this trend may very well continue into a seventh. Optimistic analysts have been predicting a government led recovery “next quarter” since late 2011, but have been repeatedly forced to push back their timeframes as the slowdown continues.

China’s leaders have been very candid about the slowdown. At the recent APEC forum in Vladivostok, China’s President Hu Jintao stated that China’s growth was facing “notable downward pressure”, “grave challenges” and worried publically about job creation for new workers entering the labor market.

There was some good news recently, as the National Development and Reform Commission (NDRC) – China’s top economic planning body – announced an impressive sounding 2000km+ of road and subway investment projects across 18 different cities. The Shanghai stock market jumped, as did Hong Kong’s main index. Yet questions remain as to just how effective this stimulus will be, whether it is large enough, and also whether or not it is actually “new” (stimulus announcements in China often include pre-approved or already underway projects which are part of older plans).

The total combined value of the projects is just over USD$150billion (or roughly CNY1trillion). This is only about one quarter the size of the massive 2008/9 stimulus and will be put into an economy that has grown larger than it was 5 years ago. In addition, roads and subways take time to be built, and thus this injection will be spread over years.

Unlike recent local government stimulus plan announcements which lacked credibility as they were mostly unfunded, projects approved by the NDRC can usually find keen lenders amongst China’s state banking system, or fiscal support from government coffers.

However, this stimulus is not worrying because of its size, or for worries about funding. The biggest worry is that it shows that China is well and truly in an 'investment trap'. With export markets still weak, investment heavy growth is becoming increasingly inefficient. The only other growth source is consumption (domestic demand), but policies which have been boosting investment also hinder consumption. To rebalance, it seems that China must therefore slow.

Slower growth, in China as anywhere, is obviously politically difficult given employment demands. It also risks exposing China’s banking system to a potentially huge pile of non-performing loans (NPLs). This is because with slower growth profits are collapsing, corporate cash flows are under pressure, and thus debt servicing abilities (the capability of companies to repay loans and interest whilst still functioning normally) are decreasing. Banks have been pushed to start rolling over local government connected NPLs, and some suspect that Chinese banks are being “creative” when classifying their loan portfolio quality. Overdue loans (not yet non-performing, but getting there) jumped markedly in several banks’ 2012 half-year results filings.

The catch-22 is that, without an economic rebalancing, continued investment-heavy growth will create an even bigger future NPL burden – as overcapacities continue to build up and ever higher amounts of credit (soon-to-be-debt) are required to maintain headline growth rates.

Hence this “stimulus” plan is mixed news. It may give a limited boost to counter the ongoing slowdown, presuming the projects can raise sufficient funding, and indeed are new. However, it is yet another investment boost to an already investment-heavy economic structure. The goals of rebalancing and maintaining growth are in short term conflict. It is not an easy time to be a Chinese economic policy maker, and the imminent leadership change which will formally begin mid-October and only be completed next spring is not making things any easier.